Table Of ContentStudies in Contemporary Economics
Editorial Board
D. Bas
B. Felderer
B. Gahlen
H. 1. Ramser
K. W. Rothschild
Eckhard Wurzel
An Econometric Analysis
of Individual
Unemployment Duration
in West Germany
With 23 Figures
Springer-Verlag Berlin Heidelberg GmbH
Dr. Eckhard Wurzel
Institut flir Intemationale Wirtschaftspolitik
Universitiit Bonn
Lennestr. 37
D-5300 Bonn 1, FRG
ISBN 978-3-7908-0681-6 ISBN 978-3-642-50298-9 (eBook)
00110.1007/978-3-642-50298-9
Die Deutsche Bibliothek -CIP·Einheitsaufnahme
Wurzel, Eckhard:
An econometric analysis of individual unemployment duration in West Germany /
Eckhard Wurzel. - Heidelberg: Physica-Verl., New York: Springer. 1993
(Studies in contemporary economics)
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© Springer-Verlag Berlin Heidelberg 1993
Originally published by Physica-Verlag Heidelberg in 1993.
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8817130-543210 -Printed on acid-free paper
To my wife and my parents
Preface
This work on the determinants of individual unemployment duration in West
Germany was begun during a one-year research term at London School of
Economics and it was continued at the Institute of International Economics of Bonn
University at which it was submitted as a doctoral thesis. I would like to thank
Professor Richard Blundell who introduced me into the most interesting field of
labor economics, Professor Manfred J. M. Neumann who was my doctoral supervisor
and with whom I had the pleasure to work for several years as an assistant, and
Professor Peter Schonfeld from whose rigorous treatment of econometric
methodology I believe to have profited a lot. I also would like to thank the
Volkswagen Foundation for financial support within the European Doctoral
Program in Quantitative Economics. Last not least I thank my wife Anette for all
her patience.
Contents
I. Introduction 1
II. Models of Individual Unemployment Duration 6
ILl Models of Labor-Leisure Choice 6
11.2 Job Search Theory 12
III. Hazard Rate Models 31
IILl Single Risk Models 31
III. 2 Competing Risks Models 35
III. 3 Parameterization of the Regression Model 39
III.4 Unobserved Heterogeneity 47
III. 5 Survey of Empirical Findings from Hazard Rate 51
Models
IV. Alternative Approaches for the Analysis of 70
Duration Data
IV.1 Time-Series Regression Analysis with Aggregate 70
Data
IV.2 Structural Job Search Models 74
IV.3 Calculation of Individual Reservation Wage 78
Elasticities
V. Sample Designs and Semi-Parametric Specification 82
V.I Sample Designs for Unemployment Duration 82
V.2 Semi-Parametric Specification of Hazard Rate 98
Models
VI. The Variables 108
VI.1 Unemployment Duration 108
V1.2 Economic and Demographic Characteristics 120
VI.3 Unemployment Benefits and Expected Earnings 127
VI.3.1 The German Unemployment Benefits System 128
x
VI.3.2 Conceptual Issues Regarding Benefits and Earnings 131
VI.3.3 Sample Information on Unemployment Benefits 134
VI.3.4 Estimation of Wage Offer Distributions 137
VII. Results of the Hazard Rate Analysis 173
VIII. Summary of Main Results and Outlook on Aggregate 211
Unemployment
Appendix: Sample Means and Standard Errors 219
References 229
I. Introduction
Traditionally, economic theory considered unemployment as a stock phenomenon to
be explained within some equilibrium or disequilibrium framework. Also, it is
usually a stock measure of unemployment, like some average unemployment ratio or
the average number of persons who happened to be unemployed within a certain
time period, that comes to the attention of the public. However, stock measures of
unemployment only provide an incomplete picture of unemployment incidence.
Unemployment is both, a stock and a flow phenomenon. One and the same stock
can be generated by an infinite number of combinations of inflow and exit
intensities into and out of unemployment, or, which is the same, of inflow intensities
and unemployment durations. Furthermore, it is a stylized fact that inflow rates
into and exit rates out of unemployment are not homogeneous over the labor force.
Given these observations, over the past twenty years labor economists paid
increasing attention to analyzing unemployment incidence at a disaggregated level.
A substantial push to research interest in this topic can roughly be dated back to
the release of the seminal volume on the microeconomics of employment and
inflation theory by Phelps et al. (1970). The research that evolved since then is
inspired by both, an immediate interest in analyzing decisions and interactions on
the level of individual agents and by the presumption that focusing on behavioral
patterns below the aggregate level can contribute to our understanding of macro
phenomena. Regarding empirical work on individual unemployment, research has
been further enhanced by the fact that data sets with disaggregated information
become increasingly available.
This empirical study examines the impact of soci~conomic variables on individual
unemployment duration. In particular, the following questions are to be analyzed:
-Unemployment duration may he affected by unemployment benefits in several
ways. Firstly, does unemployment duration increase with the level of unemployment
2
benefits? Theory predicts it does. According to the neoclassical model of labor
leisure choice the cost of leisure in terms of income forgone decreases with higher
unemployment benefits leading to a substitution of leisure for income and hence to a
longer period of unemployment. If leisure is a normal good there is an additional
income effect working in the same direction. According to search theory an increase
in unemployment benefits decreases search costs making it worthwhile to become
more choosy with respect to job offers which, on average, leads to longer
unemployment duration. Secondly, is there empirical evidence that the response to a
variation in unemployment benefits is lower for persons who receive only few job
offers? For persons with unfortunate labor market characteristics it may not pay to
become more choosy about job offers if this would reduce the job offer rate to a very
low level. Hence the search costs response predicted by search theory may be very
low or not existent. Finally, is there evidence that unemployment spells are more
frequently terminated around exhaustion points of unemployment benefits? In many
unemployment benefits systems, including the German one, unemployment benefits
lapse after a certain period. Theory suggests that the readiness to stop search and
accept employment increases once the benefits exhaustion point comes closer.
- Do higher wage offers reduce unemployment duration? Theory predicts they do;
according to neoclassical labor supply theory because the marginal cost of leisure
increases, and according to search theory because the likelihood of encountering an
acceptable job offer rises.
- Does accumulation of human capital reduce unemployment duration? To the
extent that differences in productivity are not accommodated by the wage structure
training and education are likely to affect the frequency of job offers.
- Do other demographic characteristics like sex, age and the presence of children
affect unemployment duration? If they affect the valuation of leisure they are
expected to do so. Also, if certain demographic characteristics affect costs of
production or if they act as signals about the person's productivity they are
3
expected to affect the flow of job offers, provided it is not feasible or not desirable to
"contract differences away" within the wage system.
- Is unemployment duration affected by the state the person was in before he
entered unemployment? The pre-unemployment state can influence both, a person's
recent work or training experience and his access to information about job
opportunities and job characteristics. Hence it may be relevant for the searcher's
ability to generate job offers.
Thorough examination of these questions requires statistical inference. In this study
the issues are analyzed econometrically by application of hazard rate models
utilizing longitudinal data on unemployment duration from the German Socio
Economic Panel (SEP). Formally, in the context of unemployment duration the
hazard rate denotes the conditional exit rate from unemployment given elapsed
unemployment duration since the beginning of the unemployment spell. This
concept is very useful to construct explanatory models for the probability of leaving
unemployment over time, given a set of explanatory socio--economic variables. To
minimize the impact of possible mis-specification of the probability distribution
governing the unemployment duration process the models presented are "semi
parametric" leaving the probability distribution of the duration process completely
unspecified.
The plan of this study is as follows. Chapter II. is concerned with the theoretical
framework that explains individual unemployment duration. We first consider the
determination of individual unemployment duration within the labor-leisure choice
model known from labor supply theory. Essentially, this model assumes a Walrasian
environment in which the individual chooses the length of the period over which he
wants to stay out of work. Subsequently we consider job search in a decentralized
labor market were information about job openings and wages is imperfect. Job
search models constitute the major theoretical underpinning for empirical studies of
